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Technical analysis is based entirely on the notion that everything a stock has done in the past, including its price movements and associated volumes, is indicative of what it will do in the future.
Market technicians, or “chartists” as they’re sometimes called, are less interested in balance sheets and earnings reports. They prefer to watch how investors interact with a particular company’s stock. If there’s growing momentum behind a stock’s ascent, the technical analyst will look favorably on the stock as an investment, irrespective of its latest sales numbers or dividend yield.
Price and Volume
Generally speaking, when prices are rising and volumes are increasing, a stock is a “technical buy.” When a stock is falling and volumes are decreasing, it’s a sell. This, of course, is an oversimplification, but it speaks directly to the methods of the chartist.
Let’s have a look now at two fundamental concepts of technical analysis before we move into more advanced terrain. We’ll use a chart of the top of the silver market in 2011 to help us illustrate these key terms.
Here is the iShares Silver Trust (NYSEArca: SLV), a reasonable proxy for the metal itself:
There are some key items to look at here.
First, the black box, in which you’ll find an enlarged example of an OHLC (Open-High-Low-Close) price display, as used on this chart.
Technicians are interested in as many aspects of price movement as possible, as every data point is a possible clue as to a stock’s next move. The large black bar is indicative of the full day or week or month’s price range. The top of the bar marks the period’s highs, and the bottom marks the lows. The two bars extending left and right are the period’s opening and closing prices. The graphic you’re looking at above is a weekly chart, meaning that every bar represents that week’s open, high, low and close (OHLC).
Much can be garnered from this knowledge, but we’re going to leave it for another day. Suffice for now that the above chart is a textbook case of a technical blow-off top, complete with a parabolic price rise (in red) and a concurrent massive surge in volume (in blue).
Accumulation/Distribution
Experienced technicians are on the lookout for this type of action as an indication that a stock’s rise has come to an end. The huge rise in volume in the months before and after the price spike speak to a phenomenon called “distribution,” a situation in which the stock is moving (being distributed) from stronger hands to weak.
The opposite case occurs at market bottoms, where weak hands sell their shares in droves to the “smart money” that seeks to buy them up on the cheap. That phenomenon is called “accumulation,” and it can be seen clearly on charts like this one (below), where price crashes and volume surges all at once.
The keen technician is always on the lookout for such charts as potential buying opportunities.
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